Politics, PMI amplify euro-zone debt fears

Hollande jitters, Dutch turmoil and recession fears clobber markets

By

WilliamL. Watts

FRANKFURT (MarketWatch) — If investors didn’t have enough to worry about as they watch France’s presidential election and the budget-related collapse of the Dutch government, a closely watched gauge showed Monday that business activity across the 17-nation euro area shrank at a faster pace in April.

The euro-zone preliminary composite purchasing managers’ index, or PMI, compiled by data provider Markit, fell to a five-month low of 47.4 in April from 49.1 in March, defying forecasts for a rise to 49.3. The manufacturing PMI gauge dropped to a 34-month low, while the services gauge posted its lowest reading in five months. See more on euro-zone PMI.

A reading of less than 50 signals contraction. PMI data are seen as timely and relatively reliable indicators of economic growth.

The euro
EURUSD, +0.7313%
fell to $1.3134 versus the dollar, down from $1.3219 in North American activity late Friday.

German government bonds, known as bunds, rallied on safe-haven demand, pushing yields lower. The premium demanded by investors to hold peripheral and other so-called core government bonds (including French and Dutch debt) over Germany rose.

“The flash PMI signaled a faster rate of economic contraction in the euro zone during April, extending what appears to be a double-dip recession into a third consecutive quarter, said Chris Williamson, chief economist at Markit.

The preliminary data showed that German business activity slowed to near-stagnation, while French activity posted a steep downturn potentially tied to uncertainty surrounding the country’s presidential election, Williamson added.

Hollande and Holland

France’s yield (10YR_FRA) premium over Germany (10YR_GER) at the 10-year level jumped 0.09 percentage points to a three-month high of 1.53 percentage points, according to data provider Tradeweb.

The spread between AAA-rated Dutch (10YR_NET) and German 10-year bond yields widened dramatically by 0.17 percentage point to 0.86 percentage points, its widest since 2008.

Reuters

François Hollande, the Socialist candidate for France’s presidency, arrives at his campaign headquarters in Paris early Monday.

French President Nicolas Sarkozy on Sunday became the first incumbent to fail to top a first-round presidential contest, coming in second behind Socialist challenger François Hollande out of a field of 10 candidates. Sarkozy and Hollande face each other in a May 6 runoff, with polls showing Hollande with a lead.

Sarkozy is fighting to survive amid backlash against fiscal austerity, according to Jane Foley, senior currency strategist at Rabobank International in London. He has promised to force a renegotiation of the fiscal pact agreed by euro-zone leaders at the behest of German Chancellor Angela Merkel and Sarkozy to include growth-oriented measures.

“While the lack of growth in the euro-zone region clearly does need to be addressed, [investors fear] fiscal reform could be watered down, which could open the path for a longer and potentially deeper bout of contagion in the debt markets,” Foley wrote in emailed comments.

“The strong vote of extreme right and extreme left, together [totaling] about one-third of the votes is an important sign that the debt crisis is affecting policy more profoundly,” wrote strategists at KBC Bank in Brussels.

Meanwhile, Dutch Prime Minister Mark Rutte and his cabinet tendered their resignation to Queen Beatrix on Monday after long-running budget talks collapsed over the weekend.

Reuters

Dutch Prime Minister Mark Rutte

Elections were seen as nearly inevitable after Geert Wilders, who heads the anti-euro Freedom Party, withdrew support for Rutte’s minority coalition government and called for elections “as soon as possible.” Wilders said budget cuts sought by Rutte would undercut economic growth and boost unemployment, according to a report in The Wall Street Journal.

“This political uncertainty is undermining Holland’s AAA rating — three months ago S&P warned that the rating was under threat should the economy deteriorate further,” noted Michael Derks, chief strategist at FxPro in London.

“To be honest, neither presidential candidate offers the kind of reform needed to get France back to economic success. Sarkozy didn’t achieve much in his first term in office despite promising great changes,” said Louise Cooper, markets analyst at BGC Partners in London.

“At the moment, there is little reason to believe that the relative industrial decline and competitive position of France will end. As an indicator of this, France is now borrowing more expensively than all the northern ‘hard’ states,” she wrote in a note.

Economists at ING Bank in Brussels said developments in both France and the Netherlands could mark the beginning of a change to the entire, austerity-focused “euro-zone crisis management” approach.

Meanwhile, the Bank of Spain on Monday estimated that Spanish gross domestic product contracted 0.4% in the first quarter of 2012 versus the final quarter of last year.

Spain moved into the crosshairs of bond vigilantes earlier this year after announcing it wouldn’t meet its 2012 budget target. Worries about Italy’s ability to get a grip on its debt situation also have mounted as Prime Minister Mario Monti pursues a series of controversial changes to the country’s labor rules.

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